I almost feel like I owe MFC Bancorp something but I will push my reciprocation tendency aside for a moment to once again find some value hidden under a MFC rock.
Sasamat Capital Corporation (“Sasamat”) is a way to take an equity position in one of the leading design and construction production equipment companies for cement plants around the world, KHD Humboldt Wedag (“KHD”), for 1/4 of what it would cost to buy a direct equity position in the enterprise. KHD is wholly owned by MFC Industrial Holdings AG (traded on the Frankfurt Stock Exchange), which in turn is 34% owned by Sasamat.
Sasamat has a current net asset value of approximately $65 million and sells for approximately $15 million. Sasamat is a simple company to value as it is a holding company with the following assets: cash and shares of MFC Industrial Holdings AG (“MFC Industrial”). No debt is currently outstanding and as a bonus Sasamat has past capital losses to deduct from future capital gains. Overall, this is an opportunity to purchase a dollar bill for fewer than .25 cents. Furthermore, I believe their holdings in MFC Industrial (Sasamat’s main asset) could be undervalued which only adds to the NAV.
Cash amounts to approximately $2.4 million.
MFC Industrial Equity
Sasamat currently holds 5,046,172 shares of MFC Industrial (traded on the Frankfurt Stock Exchange). MFC Industrial currently trades at approximately $10.20 Euro which equates to about $12.50. Sasamat’s MFC Industrial stock is worth approximately $63 million.
Furthermore, Sasamat has a capital loss of $11.4 million CAD which can be used to offset capital gains going forward. Their cost basis of their 5,046,172 shares of MFC Industrial is $16.1 million CAD.
Now let’s look at MFC Industrial in-depth as to why I think it may be undervalued even at its current valuation which provides for additional upside:
MFC Industrial owns 100% of KHD Humboldt-Wedag which is one of the leading suppliers of equipment and engineering services in the fields of cement, coal, and minerals processing technologies around the world.
1. KHD Humboldt Wedag (“KHD”)
KHD’s principle business is the design and construction of production equipment for cement plants around the world (however KHD also offers other services as described above). In addition, KHD owns two subsidiaries with land and buildings in Germany.
The land and building subsidiaries include (i) the 95% ownership of Altmark Industriepark AG (“Altmark”); and (ii) the 100% ownership of ZAB Zementanlagenbau Gmbh (“ZAB”).
(i) Altmark owned 650 acres of land with buildings as of December 31, 2004, which together form an industrial development area in the city of Arneburg. The first major project on this site was the construction of a kraft pulp mill following an investment of $1.2 billion.
(ii) ZAB owns approximately 28 acres of land with buildings in the city of Dessau. In the past, these properties were used for KHD’s production facilities but now they are only used for engineering and project services. The land and building are now rented out with an occupancy rate of 90% as of December 31, 2004. KHD is currently trying to divest this property.
The combined value of the real estate subsidiaries is listed on the balance sheet as held for sale with a value of approximately $34 million. This figure is most likely understated as compared to true value as KHD was acquired in a distressed situation.
Engineering and Equipment
KHD’s headquarters is in Koln, Germany, however, the company is heavily present all over the world including the rapidly growing India and Chinese markets. Humboldt Wedag India has been in business for 40 years and KHD has had a presence in China for 20 years.
KHD has rapidly grown over the past few years which can most easily be seen by looking at backlog:
Date Backlog (millions)
December 31, 2003 $131
December 31, 2004 $257
March 31, 2005 $338
June 30, 2005 $352
Approximately 60% of 2004 order intake was derived from Asia and 34% of the orders came form the markets in Europe and America for fiscal 2004.
Cement – Supply/Demand in KHD’s markets
World cement supply/demand is also in KHD’s favor. In the U.S. for instance, we have the theoretical ability to produce 93 million tons of cement per year. Cement consumption totaled 108 million tons during 2003 and has average more than 106 million tons during the past 3 years. Imports compensate for the shortfall. Currently, many plants are running 24 hours a day, seven days a week, matching or exceeding capacity maximums which even exasperates the problem should a breakdown occur.
In India, cement demand increased approximately 6.7% over the past year and demand is expected to grow 8% per year over the next 2 years according to CRIS INFAC (industry research organization). The housing sector and roads are deemed as the large cause of the demand increase.
“Chinese demand is expected to grow 5.4% annually through 2008, driven by healthy construction spending”, according to Freedonia (a leading international business research company). The ban on onsite concrete production in China also works in KHD’s favor as more cement plants will have to be constructed.
Overall, cement supply/demand factors in KHD’s markets favor further growth in backlog.
Valuation of KHD
KHD reported $128 million of revenue and my estimate of $9-$12 million of net income for the six months ended June 30, 2005 compared to $38 million of revenue and an estimated $2-3 million of net income for the six months ended June 30, 2004. Overall, I estimate KHD could earn approximately $20 million or more this year and much more in the coming few years as can be expected from the growing backlog.
At 8x next years earnings (which seems conservative compared to the growth expected in India and China for the next few years), KHD’s engineering business is worth around $160 million with an additional $34 million of real estate equating to a total value of around $194 million for MFC Industrial. Even with my conservative assumptions, MFC Industrial seems to be at least worth its current market cap of approximately $190 million and future growth in India and China could add to this figure.
Sasamat’s other assets are minimal and hence will not be considered.
No material liabilities.
In August 2005, Sasamat granted its directors stock options to acquire 1,300,000 common shares. The exercise price is the greater of (i) 80% of book value computed using the preceding quarters equity value or (ii) the market price of the shares on the grant date. If exercised today, (i) would take precedent as 80% of current book value is $3.34/share based on current equity of $21.4 million, which is 42% above the current market price.
Furthermore, Sasamat has entered into an agreement with MFC Bancorp in regards to a Euro 5,000,000 credit facility. This credit facility can be converted to common stock based on the same metrics described above in the option program.
Net Asset Value:
Overall, Sasamat’s net asset value equates to around $65 million valuing MFC Industrial equity at current market prices. With 6,407,021 shares outstanding currently, per share NAV is approximately $10.15/share (before accounting for possible tax liabilities) compared to the current $2.36/share. This equates to a 330% return or a 63% annualized return over 3 years. Even assuming to buy a decent amount of shares one must average a purchase price of $3.00/share, the 3 year annualized return lowers to about 50%/year (assuming no further appreciation of MFC Industrial equity). Liquidity has actually been pretty good for such a small capitalization stock.